Berkeley Thoughts

A surprising buyer of US equities

For the past several years we have expressed concerns about the long term implications of the policies the Central Banks of the world have used to try to revive their economies. The magnitude of money creation in the form of new dollars, yen, euros, pounds and the like are well documented. GDP growth has returned at only modest levels, but the amount of new money created in the process has grown by leaps and bounds.

The change in the assets on the balance sheet of Central Banks (shown in the chart above) is a good proxy for the amount of new money being created by Central banks. The Central Bank’s mechanism for injecting money and lowering interest rates is to purchase assets such as government bonds from the open market. Where does the Central Bank get the money to buy assets? The short answer is that money can be created with a stroke of key on a computer screen. The Central Bank is credited with currency that hereto did not exist and then takes that currency to buy real assets like bonds, which then get reflected on the Central Bank’s balance sheet. So if the balance sheets of the Central Bank is ballooning with new assets, new money had to be created to buy those assets.

After eight years, Central Banks have continued their vast money creation unabated.

As more and more currency gets created you would be right to wonder if that could one day begin to impair the value of the world currencies. Remember basic supply and demand; an increased supply of a good (i.e. currencies) should lead to a decrease in its price (or in the case of currency, a decrease in its purchasing power) if demand doesn’t increase to counter-balance. Another word for the impairment of money or the decrease in purchasing power is inflation.

But there is more to this story than Central Banks buying their own country’s sovereign bonds. In some ways that seems rather benign because many of the assets the Central Banks buy, they are buying from itself (or more accurately its country’s Treasury). Would you believe we also have Central Banks now buying interests in publicly traded companies? No way, right? The Bank of Japan has actually been “investing” in its equity markets for quite a while.

At least the Bank of Japan is creating currency and buying interests in Japanese companies. The Swiss National Bank is doing something even more unprecedented. They are buying interests in US companies and have been for the past 3 years.

The Swiss National Bank would like to make sure its currency, the Franc, doesn’t appreciate too much against its main trading partners in the Eurozone. In order to accomplish this the Swiss National Bank (SNB) creates new Francs on a computer screen. The SNB then takes its freshly created Francs and sells them for Euros or Dollars. Once the SNB acquires dollars it then goes to the US equity markets and buys real economic interest in US companies. The chart below shows some of those holdings.

Yes, the Swiss National Bank is buying significant interests in some of our most beloved and iconic companies by creating currency out of thin air. What could go wrong? And does that have any influence on our own equity prices?

Its an interesting time in the history of currency. How this plays out remains to be seen. Will Central Banks continue on this path indefinitely or will they eventually slow down. Maybe this trend is bullish for stocks – it certainly has been for the past eight years. But is it good for the purchasing power of our currency? After all, money is supposed to have some significance as a store of value. If there are no repercussions for Central Bankers printing trillion dollars of it then what’s to keep them from continuing?

E-currencies such as BitCoin have gotten a lot of press lately. We won’t speculate on whether the explosion in the price of BitCoin is sustainable or justified. It is an interesting data point today against the backdrop of the charts above. Why would anyone go for such a scheme as a currency with no central authority to control it and no banker to intervene?

Chart Below: Price of Bitcoin

Perhaps average citizens might one day begin to question whether currencies around the world can be trusted as a good store of value. Where might they turn for reassurance – maybe to one store of value that has remained consistent for centuries . . . gold.